Hot on the heels of the International Monetary Fund (IMF) asking Sri Lanka to stand ready to tighten the monetary policy further, the Central Bank last week said they would not hesitate to do so if the private sector credit reaches an unsustainable level.
Sri Lanka’s easing government securities (G-Secs) yields are yet to reflect in the bank lending rates. But the authorities may want the easing rates to stimulate the economy though higher private credit, which has the potential to destabilize the monetary sector.
Sri Lanka’s easing treasury bill rates are yet to reflect in the lending rates as the bank lending rates still remain elevated due to back-to-back policy tightening by the Central Bank since December 2015.
Sri Lanka’s benchmark bank lending rate – Average Weighted Prime Lending Rate or AWPLR – has failed to see a corresponding downward adjustment although the one-year treasury bill rate has come down by about 193 basis points to 9.10 percent by September 29 from April end’s peak.
The one-year treasury bill yield peaked on April 28 at 11.03 percent but has been easing since then although the AWPLR has come down by only 23 basis points during the same period to 11.55 percent. As a result, borrowings were contained, as the cost remained high for the borrower.
Central Bank Governor Dr. Indrajit Coomaraswamy said the reduction in the treasury bill rates is yet to reflect in bank lending rates.
“When that happens and if it leads to what the Monetary Board thinks is unsustainable credit growth then clearly action would be needed to be taken. Then we will tighten the monetary policy but we haven’t got there,” he told reporters last week.
However, some economists argue that there is a lag effect between the treasury bill rate and AWPLR, which ranges from three to six months. But the Central Bank is unlikely to allow a surge in private sector credit growth when the price pressures are already
During the first eight months, the Sri Lankan banks loaned as much as Rs.405 billion in private sector credit, little down from Rs.456 billion in the same period last year.
Although the Central Bank desired growth in private credit hovers around 15 to 16 percent for 2017, this means a whopping Rs.876 billion new credit for the year.
The IMF last week said it favoured further tightening of the monetary policy, given the price pressures and credit growth.
“The Central Bank of Sri Lanka should continue to remain vigilant in monitoring inflation pressures and stand ready to tighten monetary policy if needed to contain inflation or credit growth,” the IMF noted.
The Monetary Board did not raise concerns about the private sector credit in its monetary policy statement issued early last week.
The IMF has traditionally favoured less accommodative monetary policy in Sri Lanka as pro-accommodative policies have destabilized the economy and created balance of payment crises.
Since 2006, Sri Lanka has gone through three such boom and bust cycles of interest rates and the country is passing the final stages of the third one.